1.The process that ensures that two securities positions with identical future payoffs, regardless of future events, will have the same price is called:
  A. exchange parity.
  B. the law of one price.
  C. payoff parity.
  D. arbitrage.
  2.Assume position (X) contains risk of R(X) and position (Y) contains risk of R(Y).
  Our analysis finds that the risk of the combined portfolio R(X + Y) is greater than the sum of the individual positions risks; i.e., we find R(X + Y) > R(X) + R(Y).
  This iHustrates a violation ofwhich coherence property?
  A. Monotonicity
  B. Subadditivity
  C. Positive Homogeneity
  D. Translational invariance
  Answer:
  1.D
  If two securities have identical payoffs regardless of events, the process of arbitrage will move prices toward equality. Arbitrageurs will buy the lower priced position and sell the higher priced position, for an immediate profit without any future liability. The law of one price (for securities with identical payoffs) is not a process; it is ‘enforced’ by arbitrage.
  2.B
  Assume position (X) contains risk.
  The diversification should make the portfolio less risky, or at the very least, equally risky. The situation above ilIustrates a violation of subadditivity.